IRS Grants Extension for Late § 754 Election Following Partner’s Death

The $1M+ Mistake: Partnership’s Late § 754 Election After Partner’s Death

A partnership’s failure to file a § 754 election—a critical tax mechanism that adjusts asset bases to reflect a partner’s death—could have triggered a $1M+ tax liability in unrealized gains. Instead, the IRS granted a 120-day extension under § 301.9100-3, sparing the partnership from costly missteps. The § 754 election (Internal Revenue Code § 754) allows partnerships to align the inside basis (the partnership’s basis in its assets) with the outside basis (a partner’s basis in their partnership interest), preventing double taxation when a partner transfers their stake. Without it, the partnership risked mismatched tax treatments that could inflate taxable income or erase deductions. The IRS’s decision hinged on the partnership’s inadvertent oversight—a common pitfall when administrative errors follow a partner’s death. Relief came with conditions: the partnership must now file the election within 120 days of the IRS’s February 6, 2026 ruling, ensuring compliance while avoiding harsher penalties.

The Facts: How a Partnership Overlooked a Critical Election

The partnership was formed on Date 1 as a limited liability entity under State law, electing partnership tax treatment for federal purposes. Under Section 761(a), partnerships are pass-through entities where income, deductions, and credits flow to partners, avoiding entity-level taxation. The partnership’s operating agreement allocated profits, losses, and capital contributions among partners, including Partner A, who held a significant stake.

On Date 2, Partner A died unexpectedly, triggering a transfer of their partnership interest to their estate. Under Section 743(b), this transfer created a potential mismatch between the estate’s outside basis (reflecting the fair market value of the interest) and the partnership’s inside basis in its assets. Without a Section 754 election, the partnership risked misaligned tax treatments, where the estate could face tax liabilities on gains already embedded in the partnership’s assets.

For the taxable year ended Date 3, the partnership’s tax preparer inadvertently overlooked filing Form 1065 with the required Section 754 election statement. The oversight was not intentional but stemmed from administrative confusion following Partner A’s death, compounded by the complexity of basis adjustment rules. The failure to elect meant the partnership missed the opportunity to adjust asset bases to reflect the transfer, leaving potential tax inefficiencies unresolved.

The IRS’s Rationale: Why Relief Was Granted Under § 301.9100-3

The IRS granted relief under § 301.9100-3 because the partnership met both statutory requirements: it acted reasonably and in good faith, and granting relief would not prejudice the government’s interests.

The partnership demonstrated reasonable cause by submitting evidence of administrative confusion following Partner A’s death, including contemporaneous records showing the tax preparer’s oversight stemmed from complexity in basis adjustment rules rather than willful neglect. The preparer’s error—failing to attach the § 754 election statement to the timely-filed Form 1065—was documented as an unintentional administrative failure, not a deliberate omission. This satisfied the IRS’s standard for good faith, as the mistake arose from circumstances beyond the partnership’s control (the partner’s death) and involved technical tax compliance, not tax avoidance.

The IRS also concluded that granting relief would not prejudice the government. The late election did not result in lost tax revenue because the partnership’s § 734(b) and § 743(b) adjustments—which adjust asset bases to reflect transfers or distributions—remain available for future tax years. The IRS determined that allowing the election retroactively would correct a timing discrepancy without undermining tax collection, as the adjustments would apply prospectively to all relevant transactions.

This decision aligns with recent IRS guidance, including PLR-116211-25, which emphasizes that § 301.9100-3 relief is appropriate when taxpayers provide clear evidence of reasonable cause and the government’s interests remain protected. The IRS’s willingness to grant relief here reflects a broader trend of accommodating administrative oversights in complex partnership tax elections, provided there is no evidence of tax avoidance or intentional delay.

Conditions and Contingencies: What the Partnership Must Do Now

The IRS granted X a 120-day extension from the date of the PLR to file a § 754 election, but this relief comes with strict conditions to ensure the election’s validity. The partnership must now file the election in a written statement attached to its tax return for the affected year, ensuring the filing is processed alongside the return. A copy of this PLR must be attached to the submission—without it, the relief could be invalidated.

The partnership must also compute and apply basis adjustments under § 734(b) (for distributions) and § 743(b) (for transfers of partnership interests), even if the statutory period for filing a claim or refund has closed for prior years. These adjustments must reflect the difference between the property’s inside basis and the transferee’s outside basis, ensuring the partnership’s books align with the economic reality of the transaction. If the partnership previously filed an Administrative Adjustment Request (AAR) or must do so now, it should ensure the AAR incorporates these basis changes to avoid inconsistencies.

Finally, the partners themselves must adjust their individual outside bases in the partnership to match the revised inside basis of the assets. This step is critical because it prevents mismatches between the partnership’s tax treatment and the partners’ personal tax positions. Missing any of these steps risks the IRS denying the relief, leaving the partnership exposed to potential tax deficiencies or penalties. The IRS’s conditions are designed to protect both the government’s interests and the integrity of the tax system, ensuring that late elections do not create opportunities for abuse.

Implications: What This Means for Other Partnerships

This PLR signals the IRS’s willingness to grant relief for inadvertent failures to file a § 754 election—provided the taxpayer demonstrates reasonable cause and acts in good faith. While the ruling is non-precedential under § 6110(k)(3), it reflects a broader IRS trend toward leniency for partnerships that document their oversight and promptly seek correction. Taxpayers should not rely on such relief as a routine safeguard, but the ruling underscores the importance of maintaining meticulous records to justify late election requests.

Partnerships with frequent partner changes—such as real estate syndicates, venture capital funds, or family-owned entities—face heightened exposure to § 754 compliance risks. These industries often experience rapid shifts in ownership, making timely elections critical to avoid basis mismatches that could trigger IRS scrutiny. Similarly, partnerships relying on external tax preparers must ensure their advisors are fully versed in § 754 requirements, as preparer errors have increasingly become grounds for relief under § 301.9100-3.

The IRS’s conditions in this ruling—such as the requirement to adjust inside basis to match the revised outside basis—serve as a reminder that late elections are not without consequence. Missing the filing deadline may still expose partnerships to penalties or deficiencies if the IRS determines the delay was not justified by reasonable cause. For partnerships operating in high-turnover or complex ownership structures, proactively filing § 754 elections with each tax return—even when no transfer or distribution occurs—remains the safest path to compliance.